How will the financial turmoil affect the housing market?

Before I start, this IS a long article. I don't apologise for that, these are complex times and the more we understand about what's going on the better. However if you want to skip to the article on 'What to do if you are ....' ... a First Time Buyer; First Time Investor; Trading Up; Trading Down; Investor in trouble; Forced to Sell; Property Improver etc'

Since April 2008 I have been saying that no-one can predict what is going to happen to property prices until December 2008/January 2009. The reason? We just didn't know how bad things were going to get.

However people needed to have some idea of what was going to happen to property prices this year so they can make decisions on their property projects. As a result I gave three predications (see What's happening to Property Prices):-

The GoodThe economy stabilises and supply and demand begin to match each other by March 2009, so property prices stagnate (rather than fall).

The BadA recession ensues, causing unemployment to rise, so property prices carry on falling throughout 2009, stabilising by 2010 as confidence grows and the economy begins to improve.

The UglyAnother economic shock that we aren't expecting ensues driving us into deeper recession, higher unemployment and continues to affect property prices.

Well, sadly it seems the last few months have pushed us into the 'Ugly' scenario! It started with the rumours about the government dropping stamp duty for a year in August - this stopped people from making offers on properties and holding back sales for some weeks. As a result the property price surveys in September reported one of the worst months ever in property transactions and price falls. This has been followed by unprecedented bad news from the banking and financial sectors.

So what happens to property prices now? To some extent we still don't know - and probably won't now until February/March 2009. However we can still make some predictions about what will happen, provided that the issues with the banks and their lending IS sorted by the interest rate cuts and worldwide government propping up of banks.

To understand what will happen to property prices, we need to understand the four main factors which drive property prices up and down:-

1. Property supply and demand2. Unemployment3. Confidence in the market4. Affordability of property

These aren't necessarily in order of importance, and of course they all impact on each other, but if we take each one in turn, this will help us make some sense of what is going to happen over the coming months and more importantly what you should do if you are thinking about carrying out a property project.

Supply and DemandAround the UK there are thousands of property markets which are all reacting differently to contribute to the 'average' house prices the surveys are producing. However for most properties to be sold this year versus last, unless you are lucky enough to have a unique property with lots of buyers competing to buy it, you are likely to be looking at a 10% drop.

The reason for this is simply more properties for sale than there are buyers who can buy. Conversions rates of properties for sale versus sold have dropped from around 40% in 2007 to 14% in September 2008. This shows that last year if you looked at a page of Rightmove property results, at least 2 out 5 were 'sold subject to contract', but now you will have to scroll through page after page of properties for sale to find one that has actually sold.

The largest price drops around the country have been falls in inner city flat sales where demand has slumped as First Time Buyers hold off buying and property investors struggle to get funds. However other properties such as period homes or ones that are particularly sort after may have dropped a few percent, but nothing more.

It is only when the number and type of properties for sale start to match demand that property prices will stop falling. This year, as with last there will be something like 1.5 million properties put up for sale. While the number of property purchases are likely to be less than a million. So we clearly have an oversupply of properties for sale versus demand and this is the main reason why property prices are falling.

For prices to stop falling, people need to take their properties off the market and less new property for sale needs to come onto the market. So are there any signs that this will happen soon?

The short answer to this question is yes. New properties coming onto the market are falling and in 2009 you will be lucky to find any brand new homes being available for sale. We build around 200,000 new properties every year, in 2008 this will fall to 140,000 and may fall further in 2009. So less new builds will be for sale in 2009.

With the poor economic outlook and rising likelihood of unemployment, those that haven't sold their property for some time will take them off the market and others who were thinking about selling are likely to stay where they are. This should happen over the coming months, reducing the number of properties for sale.

So the likelihood of prices stabilising based on supply and demand, in general, is that it will start in January 2009 and is likely to start having an effect on house prices from March 2009.

UnemploymentThis is the biggest single reason why no-one can predict what's going to happen to property prices. The reason being that we just don't know how high it's going to be - and more importantly for the housing market - how many forced property sales this will cause. Forced property sales from unemployment would increase, rather than reduce, the supply of properties for sale in 2009.

Currently we have around 1.7 million unemployed and in 2009, as the recession bites, unemployment is predicted by the CBI to rise to two million. What we need to know is how many of these people have mortgages that they won't be able to afford and therefore will be forced to sell.

Based mostly on assumption plus a bit of research/back of fag packet figures the kind of people likely to be made unemployed are those that are near to retirement, those in retail and services such as restaurants and of course those lovely bankers....and associated services such as mortgage brokers.

Many of those in catering/retail are likely to be migrant workers or on low wages, so we can assume for now that they are unlikely to have mortgages. Those nearing retirement are probably not going to be too affected as they will be paying off their mortgage and hopefully getting good redundancy payouts.

Those that are likely to have mortgages and lose their jobs are the bankers and associated services. Sadly it won't be the well paid that have helped to land us in this mess, it'll be those that worked hard to support them - junior and middle management and administration staff. I've seen predictions for the financial institutions are around 20,000 but no-one knows how much associated services will be effected.

For rising unemployment to cause enough forced sales to prolong property price falls, they would have to cause 100,000+ properties to come onto the market at discounted prices. From the information we currently have, that doesn't look too likely.

ConfidenceConfidence in the economy, your job security and that property prices will rise rather than fall has a massive effect on the property market and therefore on property prices. At the moment this confidence is at rock bottom. Most people are currently moving because they have to, because of job relocation,a growing family or the three 'D's:- Death, Divorce and Debt.

The likelihood is that confidence will remain low until other stories start hogging media headlines rather than constant bad news about the financial and property market. It's not that the media are the cause of a lack of confidence, but they certainly influence people's decisions. Unfortunately until there is some good news for them to report, the market will struggle to stabilise let alone start increasing again, until there is sustained 'good news' about the housing market.

So the big question is when will 'bad news' stop and the 'good news' start?Lets all hope that the 'bad news' of banks going under stops following the government bail out. Even if it doesn't work immediately, if people are left relatively unaffected by the banking crisis (for example don't lose their deposits/jobs) then they will become immune to the 'bad news' stories. Remember the panic over Northern Rock? This wasn't repeated when Bradford and Bingley was nationalised as no-one was affected. If continued bad news about the banks/economy keeps being reported, but people's day to day life isn't affected too much they will become immune to the stories.

Although this doesn't take us into the 'good news' territory, it certainly will stop people holding off making decisions over property projects (whether to buy or sell; build an extension or a whole house etc).

However, better than this, the news about property prices is about to move from 'bad' to 'good'. Remember the first reports back in September/October 2007 about property prices starting to fall? Well that will now start working in the property market's favour.

What will happen over the next twelve months is the average house prices will be compared to lower figures from the previous year. The media will start reporting a 'slow down' in property price falls and then start talking to people who think the market might be about to bottom out rather than ones predicting a 25% drop.

So confidence that the housing market has fallen to it's lowest point is likely to start appearing in the media in the next six months. However there is one big proviso: there are no more shocks like the ones we've seen over the last few weeks and lending returns to some sort of normality.

AffordabilityMany esteemed economists still hold the view that property is 'over priced'. Unfortunately economists still don't get that property is not an 'asset' like a stock or share. It is a home and people pay what they can afford to live in one. They also need one! I don't need stocks or shares, but I do want a roof over my head. If people don't buy, they either rent or improve their current property. So certain sectors of the property market STILL grow.

This year and for the coming few months, affordability will still be an issue until lenders offer 'reasonable' rates at the 95% and 90% borrowing levels. At the moment you can only get good rates when borrowing 75%. Also, mortgage lenders need to understand that if they lend to people with small bad debt history, then they are a lot less of a risk than those horrendous debts they were happy to buy from the US!

So will lenders start lending at OK levels again?Of course! They have to. If lenders don't lend money, they can't earn any. If they don't earn, they go out of business. Lenders will need to get over their own errors and start looking more rationally at UK borrowers.

As the property market starts to settle, the lenders will want to make money from good borrowers again. They will start to compete with each other for business, loosening their lending criteria (to sensible levels) rather than continue the current 'lock down' position on anyone borrowing above 90%.

When will this happen?As no-one has any idea how well the government rescue package will work, we can't answer this precisely. As with unemployment rates, it will take us some months to be sure that the banks are back on their feet again. It will then take some months for them to ramp up their lending and start competing for borrowers.

Property Price Prediction SummaryAfter considering everything that affects the property market, and making the assumption that we have seen the worst of the banking crisis, it is likely that prices will start to stagnate from March 2009.

They will then either remain static throughout the rest of the year, probably with some blips 'going up' and some 'going down' depending on how bad the recession bites, or continue to slide downward by a few percent.

However long term (five years+) prices will start rising again. At the moment there is huge pent up demand - at least 500,000 people that would normally buy and sell during this year have not done so. It's likely another 200-300,000 will hold off next year too. This pent up demand for property will be met with poor property stock levels. The fall in supply and growth in demand for property will continue to increase the price of properties that are in short supply in the long term. It's just that we don't know when, as yet, this shift will happen.

What will influence when property prices start growing again is how deep the recession is; how much unemployment grows by; whether the banks start lending at reasonable rates at the 95% level.